Surplus Lines Insurance in Texas: A Dark Horse

Texas is the second largest surplus lines insurance market in the United States, collecting over $4 billion in premiums annually.[1] Surplus lines insurance is important as it can provide insurance to those whose needs are not met by the standard/admitted insurance market. Despite the size and importance of the surplus lines market, it is among the least understood sectors of the property and casualty industry.[2] A basic understanding of the surplus lines market will give practitioners a head start when facing some of the more complex issues that can arise from this area of the insurance marketplace.

Surplus Lines Insurance

While carriers that write coverage for the most common types of risk (i.e., home, auto, life) are licensed and closely regulated by a state’s insurance commission, and to a large degree limited to forms and language approved by that state’s governing agency, surplus lines carriers have more freedom to write policies using nonstandard language.

This freedom allows surplus lines coverage to be better tailored to address less common risks and, depending on the state, can sometimes offer more competitive rates than the possibly broader standard coverage allowed in the standard market.

For example, a new and growing insurance product is Cyber Liability Insurance, the vast majority of which is underwritten by nonadmitted carriers, as nonadmitted carriers can more rapidly modify cyber coverage in both policy language and pricing to meet the needs of a changing marketplace.[3]

Surplus lines coverage is easy to recognize as Texas law requires a surplus lines policy to contain the following language in at least 11 point font:

This insurance contract is with an insurer not licensed to transact insurance in this state and is issued and delivered as surplus lines coverage under the Texas insurance statutes. The Texas Department of Insurance does not audit the finances or review the solvency of the surplus lines insurer providing this coverage, and the insurer is not a member of the property and casualty insurance guaranty association created under Chapter 462, Insurance Code. Chapter 225, Insurance Code, requires payment of a 4.85 percent tax on gross premium.[4]

One of the drawbacks of surplus lines coverage is, as stated above, that surplus lines insurance is not backed by the Texas Property & Casualty Guaranty Fund Association, the association that pays claims in the event the insurer becomes insolvent.[5] Eligible surplus lines insurers are, however, subject to portions of Chapter 542 of the Texas Insurance Code.[6]

Surplus Lines Carriers

Of course, surplus lines carriers are not completely unregulated by the states. In order to be an eligible surplus lines carrier, the insurer must be licensed in its home country or home state to sell the kind of insurance it writes in the state in which it is not admitted.[7] Surplus carriers must also meet several requirements set forth in the Texas Insurance Code and the Texas Administrative Code, such as financial standards, payment of taxes not levied on nonsurplus insurance, and appearance on the Surplus Lines Eligibility List.[8]

Although many think of surplus lines insurers as foreign-based insurers, like Lloyd’s of London, the reality is that United States-based surplus lines insurers are responsible for approximately 70 percent of the premiums collected in Texas.[9] Moreover, many admitted insurance companies own surplus lines insurance companies. For example, Lexington Insurance Co., the largest United States-based surplus lines insurer and the second largest provider of surplus lines insurance in the country, is a member of American International Group (AIG).[10]

Surplus Lines Agents

In Texas, only licensed surplus lines agents are permitted to issue or cause to be issued insurance from surplus lines carriers.[11] Thus, a retail agent (a licensed property and casualty agent that is authorized to place insurance with admitted carriers) must contact a surplus lines agent to procure coverage in the surplus lines market.

Additionally, surplus lines coverage can only be obtained once a diligent effort is made to obtain insurance licensed in the state.[12] Because surplus lines agents act as an intermediary between the retail agent and the surplus lines insurer, they are often referred to as wholesale brokers.

Like most states, Texas regulates surplus lines agents through licensing and imposing a myriad of statutory responsibilities. For example, a surplus lines agent must make a reasonable inquiry into the financial condition and operating history of the insurer, and must stay informed of the insurer’s solvency and the soundness of its financial strength, and of the insurer’s ability to process claims and pay losses expeditiously.[13]

A surplus lines agent must notify the Texas Department of Insurance and the stamping office if the agent “has grounds to reasonably doubt the capacity, competence, stability, claim practices or business practices of an eligible surplus lines insurer,” or if the agent “has reasonable grounds to believe that an unauthorized insurer is illegally transacting the business of insurance in this state.”[14] Licensed surplus lines agents must also collect a surplus lines tax,[15] a stamping fee[16] and must timely file a copy of each executed surplus lines policy with the stamping office.[17]

Conclusion

Surplus lines coverage is a necessary part of the Texas insurance market. Surplus lines coverage is often written for specific risks that will not be covered by standard or admitted carriers. The tailoring of the coverage can lead to better and possibly more cost-effective coverage.

The mandatory inclusion of a surplus lines agent in the process can be of benefit to the consumer and retail agent in that they often possess specialized knowledge in particular lines of coverage, especially unusual types of coverage, and may possess greater access to certain insurance markets.

An understanding of the surplus lines market and the players can be legally significant. The surplus lines market is clearly different from the admitted market. Coverage counsel should be cognizant of these differences when litigating a claim involving surplus lines coverage as the policy language of a surplus lines policy could include unique language never before interpreted by a court. Additionally, issues such as jurisdiction, enforceability of policy terms, and compliance with statutory requirements can be raised in litigation involving surplus lines coverage.[18]

As society and technology continue to change, the surplus lines market will remain an essential player in the property and casualty insurance industry. Understanding the basics of this substantial and complex segment of the insurance market is necessary for all insurance practitioners.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[6] TEX. INS. CODE § 542.052. For example, a surplus lines insurer is required, no later than the 30th business day after the insurer receives notice of the claim, to acknowledge receipt of the claim, commence any investigation of the claim, and request from the claimant all items, statements and forms that the insurer reasonably believes, at that time, will be required from the claimant. TEX. INS. CODE § 542.055.

[7] 28 TEX. ADMIN. CODE § 15.8; Additionally, in 2011, Texas enacted Nonadmitted and Reinsurance Reform Act compliance legislation. The NRRA mandates that beginning July 21, 2011, the insured's home state will be the only state with jurisdiction over surplus lines transactions and the only state that can require a tax be paid by the broker. See 28 TEX. ADMIN. CODE, Chapter 15, et seq.

[11] See TEX. INS. CODE § 981.202. Texas defines a surplus lines agent as “an agent licensed under Subchapter E to procure an insurance contract from a surplus lines insurer. Some, more specialized surplus lines brokers also have authority to underwrite on behalf of insurers. These brokers are called managing underwriters. A managing underwriter is “a surplus lines agent or agency that exercises, pursuant to a written agreement with an eligible surplus lines insurer, underwriting authority for the eligible surplus lines insurer and that derives the agent or agency's business from a surplus lines agent.” Id.

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